Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Robert Shortt on 7 January and published on 7 January 2022 7 January 2022 Philip Lane, what's your response to the Eurostat flash estimate for December showing the euro area inflation on the new record high 5%. That number is broadly in line with what we expected. We’ve been clear, in recent weeks and months, that there is a peak of inflation at the end of 2021. And this number of 5 per cent in December should be interpreted in the context of the pandemic. The pandemic in 2020, the first year, led to unusually low inflation. Some of that reversed in 2021. And now, in 2022, we have a third leg of this pandemic episode, where we do think this year inflation is going to come down. It’s going to be above
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Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Robert Shortt on 7 January and published on 7 January 2022
7 January 2022
Philip Lane, what's your response to the Eurostat flash estimate for December showing the euro area inflation on the new record high 5%.
That number is broadly in line with what we expected. We’ve been clear, in recent weeks and months, that there is a peak of inflation at the end of 2021. And this number of 5 per cent in December should be interpreted in the context of the pandemic. The pandemic in 2020, the first year, led to unusually low inflation. Some of that reversed in 2021. And now, in 2022, we have a third leg of this pandemic episode, where we do think this year inflation is going to come down. It’s going to be above where we want it to be in the long term, but this three-year period – 2020, 2021, 2022 – is basically part of a pandemic cycle in inflation.
So in that sense, it should not be -- I think -- interpreted in terms of comparing to historical norms. The pandemic is a unique episode. Only a few weeks ago, in our December meeting, we looked at the prognosis for this year, for 2023, 2024, and our analysis is that inflation will be coming down in 2022. And in fact, we project inflation to be a little bit below our target in 2023 and 2024. So yes, when we hear numbers like 5 per cent in December 2021, that sounds so strange, after a long period of low inflation, but again, to repeat we do think that the inflation pressures will be easing over the course of this year. And in fact, we think inflation in 2023 and 2024 will be a little bit below where we would like it to be in terms of our target.
Are you confident that it will be noticeably weaker, which is one of the phrases one of your colleagues used, over the course of this year?
Well, I think we are confident about that for some very simple reasons. Number one is there’s a mechanical effect, which is: during the pandemic in some countries – most importantly in Germany, but also here in Ireland – in 2020 VAT rates were cut. So that meant inflation in 2020 was unusually low. When those VAT cuts were reversed in 2021, it means in 2021 inflation was temporarily high. But that is over now. In 2022, we don’t have that VAT effect, so that kind of a mechanical effect, which means that even this month of January 2022, inflation will be lower, down from December, for that very simple reason.
And what about this notion that inflation could be more stubborn and persistent than you think?
We always -- when we look at inflation -- recognise there are risks on both sides. There are risks that inflation could be above our forecasts, but also risks that inflation could be below our forecasts. So we have to look at both of those scenarios. So of course, there is a lot of attention to be paid to the scenario of inflation being above our forecast, And we will be monitoring the situation, and I think I've repeatedly said actually that the most important element of what we need to look at is what’s going to happen to wage behaviour over the course of this year.
The ECB has said that it expects energy prices to stabilise this year. What’s the basis for that belief, given that there’s such ongoing political uncertainty, particularly about gas supplies to Europe?
So, in the December numbers that came out this morning, energy prices, the whole energy category, rose by 26 per cent in 2021. Now let me also, of course, remind you that in 2020, energy prices fell. So a part of this is just a reversal. But the fact that energy prices have risen so much is a major concern. So let me generalise this point: of course, we have to think about it in terms of the inflation consequences, but the European economy is a major importer of energy. Collectively, Europe paying so much more for energy inputs is a major economic issue.
Now the fact that prices have risen so much does mean -- compared to last year’s rate of increase -- there’s probably less upside this year. But there are factors we need to look at, with geopolitical issues among them, for sure.
On the other hand, what we do think is: supply will shift, pressures should ease in the aggregate this year. In the oil market, we think supply pressures will ease. But as you indicated, the gas market is quite important for energy in Europe. And there are all sorts of different dynamics going on there. But I would remind you, of course that the supply responses are happening there as well, in terms of, for example, the shipping of liquefied natural gas around the world being redirected to Europe. So we will keep an eye on this. It’s a very important issue that’s much broader than the ECB issue. The fact that energy prices have gone up so much is a major economic policy issue in general.
The ECB significantly increased its forecast for inflation this year at the Governing Council meeting last month. And I suppose it raised a lot of eyebrows because of the scale of the revision. How confident are you now that your updated forecasts are correct?
So, in the December staff forecast, which reflected a big exercise across the Eurosystem – the ECB and the 19 central banks – that’s essentially a major exercise to come up with these forecasts. We do think it captures a lot of what is most likely to happen. And so, in terms of forecasts, it’s reflecting the most likely scenario. But as we talked about a little bit earlier on, we will be paying attention to both upside risks and downside risks to that forecast. And the energy sector is a very prominent index. We’ve just had that discussion, that there are forces on either side in relation to energy inflation.
But probably the most important message in this is: we have monthly data, as we’re talking about today. We will have new forecasts in March, in June, in September. So as the new data come in, whether it comes in stronger, exactly on track or weaker than we expected, the ECB will always be responding because we have a new strategy. And we’re crystal clear: that strategy is, we're intent on delivering inflation stabilised at 2 per cent in the medium term. So anything that threatens inflation above 2 per cent over the medium term we will be responding to. Equally, any force that threatens to push inflation below 2 per cent, we will also respond to. So this is a very clear strategy. And that essentially will guide us.
Just as a quick add-on to that question. Is it fair to say that, in the latter half of last year, the ECB was surprised by the spike in inflation?
I think that’s a fair issue. But that reflects, as we talked about, when we saw this really large surge in energy prices. That is the overwhelming dominant issue. And as I indicated, it’s much broader than just of concern for the ECB. And what’s important is: the energy sector has different components. We have what’s happening to the price of oil, and traditionally the price of oil and the price of gas have moved together, but for various reasons gas prices have moved in a different track in these months. So yes, this has been quite an event and remains something we need to look at. And, if you like, the volatility of the energy market is a primary issue for policymakers.
In simple terms, what does the ECB mean by the word “durably” to describe inflation in relation to its 2 per cent target and what kind of timescale should people understand you to mean for inflation to be moderately above target in order for you to fulfil the criteria to meet your target?
So you asked two questions there. Right now, in our December forecast, we’re looking at 2022, we’re looking at 2023 and we’re looking at 2024. Now, why do we look at these three years? Because monetary policy essentially works over a 18 month / two-year horizon. So any monetary policy move we take today would mostly show up in the inflation data in 2023 and 2024. Less so in 2022, because inflation takes a while to respond to monetary policy. So “durably” means it would be essentially a mistake to respond to inflation that’s high in 2022 but below target in 2023 and 2024. And that is essentially the notion of durability: unless we think the inflation pressure is going to remain above 2 per cent in 2023 and 2024, it would be a mistake to tighten policy in response to inflation that’s high right now.
In terms of the second question, you’ll have to remind me of the second question.
How long would inflation need to be moderately above target?
So moderately above target is a very important concept. And essentially what we need to look at is: is there any sign of today’s high inflation becoming embedded in expectations? Because, of course, if people expect the inflation rate of 3.2 per cent in 2022 to persist in 2023, 2024 and beyond, then it may change pricing behaviour, wage behaviour in a self-fulfilling way. So that is really the criterion: are we seeing inflation, persistent inflation, being converted into actions, into new types of wage-setting behaviour, price-setting behaviour? And so, if inflation is temporarily above target, people understand it’s not going to last. That’s very different to if inflation – let’s say, the 3.2 number we have today. If that 3.2 number is expected to repeat, that would be a problem. But what we don’t see is evidence of that. What we see is not just our own forecast, but the behaviour of consumers, the behaviour of firms, the financial markets. All agree with us in the sense of believing that, more likely than not, inflation in 2023, 2024 will be below our target, not above our target.
House prices have accelerated sharply across the euro area countries, including Ireland. Do you accept, as some people have said, that part of the reason may be an unintended side effect of loose monetary policy?
So let me emphasise – I think you have a fair characterisation of the issue there – certainly monetary policy is one factor in the housing market. But even there, let me emphasise: it’s on both sides. So, low interest rates help to finance construction, it helps to repair the supply deficiency that we see in so many parts of Europe. There is a lack of construction activity. So low interest rates are part of the supply-side mechanism. On the other hand, low interest rates are also on the demand side. And this is why it’s so important that other supply policies are implemented. And also on the demand side, it is so important that countries have robust macroprudential frameworks. Ireland has this with the mortgage rules, but there’s a more general move across Europe to make sure that countries recognise that monetary policy on its own cannot be expected to manage the risks in the housing market. We also need broader macroprudential policies, which more and more countries are rolling out, including here.
I suppose for most people, when they think about monetary policy and they think about inflation, they actually just want to know “look, are interest rates going to go up or not?” At the last Governing Council meeting, the President of the ECB reiterated yet again that it was highly unlikely that interest rates may change this year, in 2022. Is that still the case?
Yes, that remains the case. We went through this comprehensive assessment in December. And again, to repeat, we do think inflation in 2022 will be temporarily above our target. But we do think inflation is going to come down below our target in 2023 and 2024. We try to be super clear about the criteria we use in making interest rate decisions and, going over what we talked about, when we think the high inflation is not going to be durable, the case for altering our interest rate policy is not there.
But, of course, let me repeat: we will have new data coming in all year long. And you can expect the ECB to be paying a lot of attention to all of that data. And again, it’s data about what’s happening this year. It’s also data about the future. I mean: are we seeing changes in labour markets? Are we seeing changes in energy markets, in goods markets? So it’s always two-sided. One focus is on what’s happening right now. The other one is trying to get a little bit of a crystal ball answer and work out: are there structural changes in the economy that might affect our views about the later years? But right now, going back to what I said earlier on, one of the big issues for us this year is: what’s happening in terms of wage behaviour. We do expect wages to pick up; that reflects – quite – the fact that the labour market has been more resilient in the pandemic, thanks of course to extensive government supports many labour markets. And if we have a stronger labour market in the coming years, then we should have stronger wage behaviours than before the pandemic. So, to some extent, that’s going to be what we want. But of course, we have to keep an eye out on whether wages will move beyond that and move into the kind of second-round effect, which would be something of a concern.